The Cyprus Bailout includes the Confiscation of People’s Personal Savings

Posted by PITHOCRATES - March 17th, 2013

Week in Review

President Obama isn’t worried about the deficit.  Or the debt.  Neither are Democrats.  Who see no problem with increasing federal spending even more.  Probably because there are Nobel Prize winning economists like Paul Krugman saying deficit spending is a good thing. Because what can possible go wrong with spending money you don’t have?  No doubt the very same things they were saying in Greece.  Italy.  And Cyprus (see Analysis: Cyprus bank levy risks dangerous euro zone precedent by Mike Peacock posted 3/17/2013 on Reuters).

A hit imposed on Cypriot bank depositors by the euro zone has shocked and alarmed politicians and bankers who fear the currency bloc has set a precedent that will unnerve investors and citizens alike.

After all-night Friday talks, euro finance ministers agreed a 10 billion euro ($13 billion) bailout for the stricken Mediterranean island and said since so much of its debt was rooted in its banks, that sector would have to bear a large part of the burden.

In a radical departure from previous aid packages – and one that gave rise to incredulity and anger across Cyprus – the ministers are forcing the nation’s savers to pay up to 10 percent of their deposits to raise almost 6 billion euros…

The decision sent Cypriots scurrying to the cash points, most of which were emptied within hours. Most have been unable to access their bank accounts since Saturday morning, a move unlikely to engender calm…

A Cypriot bank holiday on Monday will limit any immediate reaction. The deposit levy – set at 9.9 percent on bank deposits exceeding 100,000 euros and 6.7 percent on anything below that – will be imposed on Tuesday, if voted through in parliament…

“I understand that electorates in Germany and northern Europe demand some sacrifice. However, when you accept a solution that basically expropriates 10 percent of deposits, you set a dangerous precedent,” Vladimir Dlouhy, former Czech economy minister and now international advisor for Goldman Sachs told Reuters in Berlin. “If we get into deeper trouble, God help us, they may try to take 50 percent.”

Ouch.  That’s what can go wrong with too much government spending.  And too much debt.  The government will just seize your money.  Scary.  Hearing stuff like this makes you pay a little more attention to that idea someone floated about the government expropriating 401(k) retirement accounts.  Taking our retirement money.  But being magnanimous enough about it to give us something valuable in return.  A promise to pay us a fixed retirement benefit.  Something as reliable and solvent as Social Security.  Preferably like it used to be.  Before they began forecasting it was going bankrupt.

So this is the downside to spending money you don’t have.  Bank runs.  As people pull their money out of our banks before the government can seize it.  Causing banks to fail.  Crashing the economy into a depression.  Just like all those bank failures in the Thirties caused the Great Depression.  But other than this there is little to worry about spending money you don’t have.

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The Federal Reserve, Roaring Twenties, Stock Market Crash, Banking Crises, Great Depression and John Maynard Keynes

Posted by PITHOCRATES - September 25th, 2012

History 101

The Federal Reserve increased the Money Supply to Lower Interest Rates during the Roaring Twenties

Benjamin Franklin said, “Industry, perseverance, & frugality, make fortune yield.”  He said that because he believed that.  And he proved the validity of his maxim with a personal example.  His life.  He worked hard.  He never gave up.  And he was what some would say cheap.  He saved his money and spent it sparingly.  Because of these personally held beliefs Franklin was a successful businessman.  So successful that he became wealthy enough to retire and start a second life.  Renowned scientist.  Who gave us things like the Franklin stove and the lightning rod.  Then he entered his third life.  Statesman.  And America’s greatest diplomat.  He was the only Founder who signed the Declaration of Independence, Treaty of Amity and Commerce with France (bringing the French in on the American side during the Revolutionary War), Treaty of Paris (ending the Revolutionary War very favorably to the U.S.) and the U.S. Constitution.  Making the United States not only a possibility but a reality.  Three extraordinary lives lived by one extraordinary man.

Franklin was such a great success because of industry, perseverance and frugality.  A philosophy the Founding Fathers all shared.  A philosophy that had guided the United States for about 150 years until the Great Depression.  When FDR changed America.  By building on the work of Woodrow Wilson.  Men who expanded the role of the federal government.  Prior to this change America was well on its way to becoming the world’s number one economy.   By following Franklin-like policies.  Such as the virtue of thrift.  Favoring long-term savings over short-term consumption.  Free trade.  Balanced budgets.  Laissez-faire capitalism.  And the gold standard.  Which provided sound money.  And an international system of trade.  Until the Federal Reserve came along.

The Federal Reserve (the Fed) is America’s central bank.  In response to some financial crises Congress passed the Federal Reserve Act (1913) to make financial crises a thing of the past.  The Fed would end bank panics, bank runs and bank failures.  By being the lender of last resort.  While also tweaking monetary policy to maintain full employment and stable prices.  By increasing and decreasing the money supply.  Which, in turn, lowers and raises interest rates.  But most of the time the Fed increased the money supply to lower interest rates to encourage people and businesses to borrow money.  To buy things.  And to expand businesses and hire people.  Maintaining that full employment.  Which they did during the Roaring Twenties.  For awhile.

The Roaring Twenties would have gone on if Herbert Hoover had continued the Harding/Mellon/Coolidge Policies

The Great Depression started with the Stock Market Crash of 1929.  And to this date people still argue over the causes of the Great Depression.  Some blame capitalism.  These people are, of course, wrong.  Others blamed the expansionary policies of the Fed.  They are partially correct.  For artificially low interest rates during the Twenties would eventually have to be corrected with a recession.  But the recession did not have to turn into a depression.  The Great Depression and the banking crises are all the fault of the government.  Bad monetary and fiscal policies followed by bad governmental actions threw an economy in recession into depression.

A lot of people talk about stock market speculation in the Twenties running up stock prices.  Normally something that happens with cheap credit as people borrow and invest in speculative ventures.  Like the dot-com companies in the Nineties.  Where people poured money into these companies that never produced a product or a dime of revenue.  And when that investment capital ran out these companies went belly up causing the severe recession in the early 2000s.  That’s speculation on a grand scale.  This is not what happened during the Twenties.  When the world was changing.  And electrifying.  The United States was modernizing.  Electric utilities, electric motors, electric appliances, telephones, airplanes, radio, movies, etc.  So, yes, there were inflationary monetary policies in place.  But their effects were mitigated by this real economic activity.  And something else.

President Warren Harding nominated Andrew Mellon to be his treasury secretary.  Probably the second smartest person to ever hold that post.  The first being our first.  Alexander Hamilton.  Harding and Mellon were laissez-faire capitalists.  They cut tax rates and regulations.  Their administration was a government-hands-off administration.  And the economy responded with some of the greatest economic growth ever.  This is why they called the 1920s the Roaring Twenties.  Yes, there were inflationary monetary policies.  But the economic growth was so great that when you subtracted the inflationary damage from it there was still great economic growth.  The Roaring Twenties could have gone on indefinitely if Herbert Hoover had continued the Harding and Mellon policies (continued by Calvin Coolidge after Harding’s death).  There was even a rural electrification program under FDR’s New Deal.  But Herbert Hoover was a progressive.  Having far more in common with the Democrat Woodrow Wilson than Harding or Coolidge.  Even though Harding, Coolidge and Hoover were all Republicans.

Activist Intervention into Market Forces turned a Recession into the Great Depression

One of the things that happened in the Twenties was a huge jump in farming mechanization.  The tractor allowed fewer people to farm more land.  Producing a boom in agriculture.  Good for the people.  Because it brought the price of food down.  But bad for the farmers.  Especially those heavily in debt from mechanizing their farms.  And it was the farmers that Hoover wanted to help.  With an especially bad policy of introducing parity between farm goods and industrial goods.  And introduced policies to raise the cost of farm goods.  Which didn’t help.  Many farmers were unable to service their loans with the fall in prices.  When farmers began to default en masse banks in farming communities failed.  And the contagion spread to the city banks.  Setting the stage for a nation-wide banking crisis.  And the Great Depression.

One of the leading economists of the time was John Maynard Keynes.  He even came to the White House during the Great Depression to advise FDR.  Keynes rejected the Franklin/Harding/Mellon/Coolidge policies.  And the policies favored by the Austrian school of economics (the only people, by the way, who actually predicted the Great Depression).  Which were similar to the Franklin/Harding/Mellon/Coolidge policies.  The Austrians also said to let prices and wages fall.  To undo all of that inflationary damage.  Which would help cause a return to full employment.  Keynes disagreed.  For he didn’t believe in the virtue of thrift.  He wanted to abandon the gold standard completely and replace it with fiat money.  That they could expand more freely.  And he believed in demand-side solutions.  Meaning to end the Great Depression you needed higher wages not lower wages so workers had more money to spend.  And to have higher wages you needed higher prices.  So the employers could pay their workers these higher wages.  And he also encouraged continued deficit spending.  No matter the long-term costs.

Well, the Keynesians got their way.  And it was they who gave us the Great Depression.  For they influenced government policy.  The stock market crashed in part due to the Smoot Hawley Tariff then in committee.  But investors saw the tariffs coming and knew what that would mean.  An end to the economic boom.  So they sold their stocks before it became law.  Causing the Stock Market Crash of 1929.  Then those tariffs hit (an increase of some 50%).  Then they doubled income tax rates.  And Hoover even demanded that business leaders NOT cut wages.  All of this activist intervention into market forces just sucked the wind out of the economy.  Turning a recession into the Great Depression.

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Federal Reserve System, Great Depression, Banking Crises, Gold Reserves, Gold Exchange Standard, Interest Rates and Money Supply

Posted by PITHOCRATES - July 31st, 2012

History 101

The Gold Exchange Standard provided Stability for International Trade

Congress created the Federal Reserve System (the Fed) with the passage of the Federal Reserve Act in 1913.  They created the Fed because of some recent bad depressions and financial panics.  Which they were going to make a thing of the past with the Fed.  It had three basic responsibilities.  Maximize employment.  Stabilize prices.  And optimize interest rates.  With the government managing these things depressions and financial panics weren’t going to happen on the Fed’s watch.

The worst depression and financial panic of all time happened on the Fed’s watch.  The Great Depression.  From 1930.  Until World War II.  A lost decade.  A period that saw the worst banking crises.  And the greatest monetary contraction in U.S. history.  And this after passing the Federal Reserve Act to prevent any such things from happening.  So why did this happen?  Why did a normal recession turn into the Great Depression?  Because of government intervention into the economy.  Such as the Smoot-Hawley Tariff Act that triggered the great selloff and stock market crash.  And some really poor monetary policy.  As well as bad fiscal policy.

At the time the U.S. was on a gold exchange standard.  Paper currency backed by gold.  And exchangeable for gold.  The amount of currency in circulation depended upon the amount of gold on deposit.  The Federal Reserve Act required a gold reserve for notes in circulation similar to fractional reserve banking.  Only instead of keeping paper bills in your vault you had to keep gold.  Which provided stability for international trade.  But left the domestic money supply, and interest rates, at the whim of the economy.  For the only way to lower interest rates to encourage borrowing was to increase the amount of gold on deposit.  For with more gold on hand you can increase the money supply.  Which lowered interest rates.  That encouraged people to borrow money to expand their businesses and buy things.  Thus creating economic activity.  At least in theory.

The Fed contracted the Money Supply even while there was a Positive Gold Flow into the Country

The gold standard worked well for a century or so.  Especially in the era of free trade.  Because it moved trade deficits and trade surpluses towards zero.  Giving no nation a long-term advantage in trade.  Consider two trading partners.  One has increasing exports.  The other increasing imports.  Why?  Because the exporter has lower prices than the importer.  As goods flow to the importer gold flows to the exporter to pay for those exports.  The expansion of the local money supply inflates the local currency and raises prices in the exporter country.  Back in the importer country the money supply contracts and lowers prices.  So people start buying more from the once importing nation.  Thus reversing the flow of goods and gold.  These flows reverse over and over keeping the trade deficit (or surplus) trending towards zero.  Automatically.  With no outside intervention required.

Banknotes in circulation, though, required outside intervention.  Because gold isn’t in circulation.  So central bankers have to follow some rules to make this function as a gold standard.  As gold flows into their country (from having a trade surplus) they have to expand their money supply by putting more bills into circulation.  To do what gold did automatically.  Increase prices.  By maintaining the reserve requirement (by increasing the money supply by the amount the gold deposits increased) they also maintain the fixed exchange rate.  An inflow of gold inflates your currency and an outflow of gold deflates your currency.  When central banks maintain this mechanism with their monetary policy currencies remain relatively constant in value.  Giving no price advantage to any one nation.  Thus keeping trade fair.

After the stock market crash in 1929 and the failure of the Bank of the United States in New York failed in 1930 the great monetary contraction began.  As more banks failed the money they created via fractional reserve banking disappeared.  And the money supply shrank.  And what did the Fed do?  Increased interest rates.  Making it harder than ever to borrow money.  And harder than ever for banks to stay in business as businesses couldn’t refinance their loans and defaulted.  The Fed did this because it was their professional opinion that sufficient credit was available and that adding liquidity then would only make it harder to do when the markets really needed additional credit.  So they contracted the money supply.  Even while there was a positive gold flow into the country.

The Gold Standard works Great when all of your Trading Partners use it and they Follow the Rules

Those in the New York Federal Reserve Bank wanted to increase the money supply.  The Federal Reserve Board in Washington disagreed.  Saying again that sufficient credit was available in the market.  Meanwhile people lost faith in the banking system.  Rushed to get their money out of their bank before it, too, failed.  Causing bank runs.  And more bank failures.  With these banks went the money they created via fractional reserve banking.  Further deflating the money supply.  And lowering prices.  Which was the wrong thing to happen with a rising gold supply.

Well, that didn’t last.  France went on the gold standard with a devalued franc.  So they, too, began to accumulate gold.  For they wanted to become a great banking center like London and New York.  But these gold flows weren’t operating per the rules of a gold exchange.  Gold was flowing generally in one direction.  To those countries hoarding gold.  And countries that were accumulating gold weren’t inflating their money supplies to reverse these flows.  So nations began to abandon the gold exchange standard.  Britain first.  Then every other nation but the U.S.

Now the gold standard works great.  But only when all of your trading partners are using it.  And they follow the rules.  Even during the great contraction of the money supply the Fed raised interest rates to support the gold exchange.  Which by then was a lost cause.  But they tried to make the dollar strong and appealing to hold.  So people would hold dollars instead of their gold.  This just further damaged the U.S. economy, though.  And further weakened the banking system.  While only accelerating the outflow of gold.  As nations feared the U.S. would devalue their currency they rushed to exchange their dollars for gold.  And did so until FDR abandoned the gold exchange standard, too, in 1933.  But it didn’t end the Great Depression.  Which had about another decade to go.

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World War I, Gold Standard, German Reparations, Hyperinflation, Credit-Anstalt, Keynesian Policies and the Great Depression

Posted by PITHOCRATES - March 13th, 2012

History 101

Nations abandoned the Gold Standard to Borrow and Print Money freely to pay for World War I 

Banks loan to each other.  They participate in a banking system that moves capital from those who have it to those who need it.  It’s a good system.  And a system that works.  Providing businesses and entrepreneurs with the capital to expand their businesses.  And create jobs.  As long as all the banks in the system go about their business responsibly.  And their governments go about their business responsibly.  Sadly, neither always does.

World War I changed the world in so many ways for the worse.  It killed a generation of Europeans.  Bankrupted nations.  Redrew the borders in Europe as the victors divvied up the spoils of war.  Setting the stage for future political unrest.  Gave us Keynesian economics.  Saw the beginning of the decline of the gold standard.  A deterioration of international trade.  A rise of protectionism and nationalism.  Punishing German reparations.  To pay for a war that they didn’t necessarily start.  Nor did they necessarily lose.  Which created a lot of anger in Germany.  And provided the seed for the Great Depression.

A set of entangling treaties brought nations eagerly into World War I.  There was great patriotic fervor.  And a belief that this war would be Napoleonic.  Some glorious battles.  With the victors negotiating a favorable peace.  Sadly, no one learned the lessons of the Crimean War (1853-1856).  Which killed approximately 600,000 (about 35% of those in uniform).  Or the American Civil War (1861-1865).  Which killed approximately 600,000 (about 20% of those in uniform).  The first modern wars.  Where the technology was ahead of the Napoleonic tactics of the day.  Modern rifled weapons made accurate killing weapons.  And the telegraph and the railroads allowed the combatants to rush ever more men into the fire of those accurate killing weapons.  These are the lessons they didn’t learn.  Which was a pity.  Because the weapons were much more lethal in World War I (1914-1918).  And far more advanced than the tactics of the day.  Which were still largely Napoleonic.  Mass men on the field of battle.  Fire and advance.  And close with the bayonet.  Which they did in World War I.  And these soldiers advanced into the withering fire of the new machine gun.  While artillery rounds fell around them.  Making big holes and throwing shredded shrapnel through flesh and bone.  WWI killed approximately 10,000,000 (about 15% of those in uniform).  And wounded another 20 million.  To do that kind of damage costs a lot of money.  Big money.  For bullets, shells, rifles, artillery, machine guns, warships, planes, etc., don’t grow on trees.  Which is why all nations (except the U.S.) went off of the gold standard to pay for this war.  To shake off any constraints to their ability to raise the money to wage war.  To let them borrow and print as much as they wanted.  Despite the effect that would have on their currency.  Or on foreign exchange rates.

As Countries abandoned the Gold Standard they depreciated their Currencies and wiped out People’s Life Savings

Well, the war had all but bankrupted the combatants.  They had huge debts and inflated currencies.  Large trade deficits.  And surpluses.  A great imbalance of trade.  And it was in this environment that they restored some measure of a gold standard.  Which wasn’t quite standard.  As the different nations adopted different exchange rates.  But they moved to get their financial houses back in order.  And the first order of business was to address those large debts.  And the ‘victors’ decided to squeeze Germany to pay some of that debt off.  Hence those punishing reparations.  Which the victors wanted in gold.  Or foreign currency.  Which made it difficult for Germany to return to the gold standard.  As the victors had taken most of her gold.  And so began the hyperinflation.  As the Germans printed Marks to trade for foreign currency.  Of course we know what happened next.  They devalued the Mark so much that it took wheelbarrows full of them to buy their groceries.  And to exchange for foreign currency.

Elsewhere, in the new Europe that emerged from WWI, there was a growth in regional banking.  Savvy bankers who were pretty good at risk evaluation.  Who were close to the borrowers.  And informed.  Allowing them to write good loans.  Meanwhile, the old institutions were carrying on as if it was still 1914.  Not quite as savvy.  And making bad loans.  The ones the more savvy bankers refused to write.  Weak banking regulation helped facilitate these bad lending practices.  Leaving a lot of banks with weak balance sheets.  Add in the hyperinflation.  Heavy debts.  Higher taxes (to reduce those debts).  Trade imbalances.  And you get a bad economy.  Where businesses were struggling to service their debt.  With many defaulting.  As a smaller bank failed a bigger bank would absorb it.  Bad loans and all.  Including an Austrian bank.  A pretty big one at that.  The largest in Austria.  Credit-Anstalt.  Which was ‘too big to fail’.  But failed anyway.  And when it did the collapse was heard around the world. 

As banks failed the money supply contracted.  Causing a liquidity crisis.  And deflation (less money chasing the same amount of goods).  Currency appreciation (further hurting a country’s balance of trade).  And low prices.  Which made it harder for borrowers to service their debt with the lower revenue they earned on those lower prices.  So there were more loan defaults.  Bank runs.  And bank failures.  Spreading the contagion to Amsterdam.  To Warsaw.  Germany.  Latvia.  Turkey.  Egypt.  Britain.  Even the U.S.  Soon countries abandoned the gold standard.  So they could print money to save the banks.  Lower interest rates.  Depreciate their currencies.  And wipe out large swathes of wealth denominated in that now depreciated currency.  What we call Keynesian policies.  People’s life savings became a fraction of what they were.  Making for a longer working life.  And a more Spartan retirement. 

Abandoning the Gold Standard didn’t fix the U.S. Economy in 1971

Meanwhile in the U.S. the government was destroying the U.S. economy.  Trying to protect domestic prices they passed the Smoot-Hawley Tariff.  Raising the price for businesses and consumers alike.  And kicking off a trade war.  Both of which greatly reduced U.S. exports.  New labor legislation keeping wages above market prices while all other prices were falling.  And higher taxes to pay for New Deal social programs.  Wiping out business profits and causing massive unemployment.  Then came the fall in farm prices due to increased farm productivity.  Thanks to farmers mechanizing their farms and greatly increasing their harvests.  Thus lowering prices.  Making it hard to service the bank loans they got to pay for that mechanization.  Thus leading to bank failures in the farming regions.  That spread to the cities.  Causing a liquidity crisis.  And deflation.

Then came Credit-Anstalt.  And all the woe that followed.  Which caused a speculative run in Britain.  Which made the British decide to leave the gold standard.  To stem the flow of gold out of their country.  Which destroyed whatever confidence was still remaining in their banking system.  People thought that the U.S. would be next.  But the Americans defended the dollar.  And instead raised interest rates (by reducing the money supply).  To keep the dollar valuable.  And to protect the exchange rate.  Making it less attractive to exchange cash for gold.  And to restore confidence in the banking system.  Of course, this didn’t help the liquidity crisis.  Which Keynesians blame for the length and the severity of the Great Depression.

Of course, it wasn’t the gold standard that caused the fall of Credit-Anstalt.  It was poor lending practices.  A weak banking regulation that allowed those poor lending practices.  And a lot of bad government policy throughout Europe.  Especially those punishing German reparations.  And the gold standard didn’t cause the economic collapse in the United States.  For it worked well the previous decade.  Providing all the capital required to produce the Roaring Twenties that modernized the world.  It was government and their intrusive policies into the free market that caused the economic collapse.  And abandoning the gold standard wouldn’t have changed that.  Or made the economy better.  And we know this because leaving the gold standard didn’t solve all of the countries woes in 1971.  Because the government was still implementing bad Keynesian policies.

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Financial Crises: The Fed Giveth and the Fed Taketh Away

Posted by PITHOCRATES - December 3rd, 2010

Great Depression vs. Great Recession

Ben Bernanke is a genius.  I guess.  That’s what they keep saying at least. 

The chairman of the Federal Reserve is a student of the Great Depression, that great lesson of how NOT to implement monetary policy.  And because of his knowledge of this past great Federal Reserve boondoggle, who better to fix the present great Federal Reserve boondoggle?  What we affectionately call the Great Recession.

There are similarities between the two.  Government caused both.  But there are differences.  Bad fiscal policy brought on a recession in the 1920s.  Then bad monetary policy exasperated the problem into the Great Depression. 

Bad monetary policy played a more prominent role in the present crisis.  It was a combination of cheap money and aggressive government policy to put people into houses they couldn’t afford that set off an international debt bomb.  Thanks to Fannie Mae and Freddie Mac buying highly risky mortgages and selling them as ‘safe’ yet high-yield investments.  Those rascally things we call derivatives.

The Great Depression suffered massive bank failures because the lender of last resort (the Fed) didn’t lend.  In fact, they made it more difficult to borrow money when banks needed money most.  Why did they do this?  They thought rich people were using cheap money to invest in the stock market.  So they made money more expensive to borrow to prevent this ‘speculation’.

The Great Recession suffered massive bank failures because people took on great debt in ideal times (low interest rates and increasing home values).  When the ‘ideal’ became real (rising interest rates and falling home values), surprise surprise, these people couldn’t pay their mortgages anymore.  And all those derivatives became worthless. 

The Great Depression:  Lessons Learned.  And not Learned.

Warren G. Harding appointed Andrew Mellon as his Secretary of the Treasury.  A brilliant appointment.  The Harding administration cut taxes.  The economy surged.  Lesson learned?  Lower taxes stimulate the economy.  And brings more money into the treasury.

The Progressives in Washington, though, needed to buy votes.  So they tinkered.  They tried to protect American farmers from their own productivity.  And American manufacturers.  Also from their own productivity.  Their protectionist policies led to tariffs and an international trade war.  Lesson not learned?  When government tinkers bad things happen to the economy.

Then the Fed stepped in.  They saw economic activity.  And a weakening dollar (low interest rates were feeding the economic expansion).  So they strengthened the dollar.  To keep people from ‘speculating’ in the stock money with borrowed money.  And to meet international exchange rate requirements.  This led to bank failures and the Great Depression.  Lesson not learned?   When government tinkers bad things happen to the economy.

Easy Money Begets Bad Debt which Begets Financial Crisis

It would appear that Ben Bernanke et al learned only some of the lessons of the Great Depression.  In particular, the one about the Fed’s huge mistake in tightening the money supply.  No.  They would never do that again.  Next time, they would open the flood gates (see Fed aid in financial crisis went beyond U.S. banks to industry, foreign firms by Jia Lynn Yang, Neil Irwin and David S. Hilzenrath posted 12/2/2010 on The Washington Post).

The financial crisis stretched even farther across the economy than many had realized, as new disclosures show the Federal Reserve rushed trillions of dollars in emergency aid not just to Wall Street but also to motorcycle makers, telecom firms and foreign-owned banks in 2008 and 2009.

The Fed’s efforts to prop up the financial sector reached across a broad spectrum of the economy, benefiting stalwarts of American industry including General Electric and Caterpillar and household-name companies such as Verizon, Harley-Davidson and Toyota. The central bank’s aid programs also supported U.S. subsidiaries of banks based in East Asia, Europe and Canada while rescuing money-market mutual funds held by millions of Americans.

The Fed learned its lesson.  Their easy money gave us all that bad debt.  And we all learned just how bad ‘bad debt’ can be.  They wouldn’t make that mistake again.

The data also demonstrate how the Fed, in its scramble to keep the financial system afloat, eventually lowered its standards for the kind of collateral it allowed participating banks to post. From Citigroup, for instance, it accepted $156 million in triple-C collateral or lower – grades that indicate that the assets carried the greatest risk of default.

Well, maybe next time.

You Don’t Stop a Run by Starting a Run

With the cat out of the bag, people want to know who got these loans.  And how much each got.  But the Fed is not telling (see Fed ID’s companies that used crisis aid programs by Jeannine Aversa, AP Economics Writer, posted 12/1/2010 on Yahoo! News).

The Fed didn’t take part in that appeal. What the court case could require — but the Fed isn’t providing Wednesday — are the names of commercial banks that got low-cost emergency loans from the Fed’s “discount window” during the crisis.

The Fed has long acted as a lender of last resort, offering commercial banks loans through its discount window when they couldn’t obtain financing elsewhere. The Fed has kept secret the identities of such borrowers. It’s expressed fear that naming such a bank could cause a run on it, defeating the purpose of the program.

I can’t argue with that.  For this was an important lesson of the Great Depression.  When you’re trying to stop bank runs, you don’t advertise which banks are having financial problems.  A bank can survive a run.  If everyone doesn’t try to withdraw their money at the same time.  Which they may if the Fed advertises that a bank is going through difficult times.

When Fiscal Responsibility Fails, Try Extortion

Why does government always tinker and get themselves into trouble?  Because they like to spend money.  And control things.  No matter what the lessons of history have taught us.

Cutting taxes stimulate the economy.  But it doesn’t buy votes.  You need people to be dependent on government for that.  So no matter what mess government makes, they NEVER fix their mess by shrinking government or cutting taxes.  Even at the city level. 

When over budget what does a city do?  Why, they go to a favored tactic.  Threaten our personal safety (see Camden City Council Approves Massive Police And Fire Layoffs Reported by David Madden, KYW Newsradio 1060, posted 12/2/2010 on philadelphia.cbslocal.com).

Camden City Council, as expected, voted Thursday to lay off almost 400 workers, half of them police officers and firefighters, to bridge a $26.5 million deficit.

There’s a word for this.  And it’s not fiscal responsibility.  Some would call it extortion.

It’s never the pay and benefits of the other city workers.  It’s always the cops and firefighters.  Why?  Because cutting the pay and benefits of a bloated bureaucracy doesn’t put the fear of God into anyone.

Here we go Again

We never learn.  And you know what George Santayana said.  “Those who cannot remember the past are condemned to repeat it.”  And here we are.  Living in the past.  Again.

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LESSONS LEARNED #28: “Politicians love failure because no one ever asked government to fix something that was working.” -Old Pithy

Posted by PITHOCRATES - August 26th, 2010

THE TELEVISION SHOW Gomer Pyle, U.S.M.C. aired from 1964-1969.  It was a spinoff from the Andy Griffith Show.  Gomer, a naive country bumpkin who worked at Wally’s filling station, joined the Marines Corps.  And there was much mirth and merriment.  To the chagrin of Sergeant Carter, Pyle’s drill instructor (DI).  Think of Gunny Sergeant R. Lee Ermey’s Sergeant Hartman in the movie Full Metal Jacket only with no profanity or mature subject matter.  Sergeant Carter was a tough DI like Sergeant Hartman.  But more suitable for the family hour on prime time television.

Gunny sergeants are tough as nails.  And good leaders.  They take pride in this.  But sometimes a gunny starts to feel that he’s not himself anymore.  This was the subject of an episode.  And Gomer, seeing that Sergeant Carter was feeling down, wanted to help.  So he stuffed Sergeant Carter’s backpack with hay before a long march.  While the platoon was worn and tired, Sergeant Carter was not.  He was feeling good.  Like his old self.  Until he found out he was not carrying the same load his men were.  He asked Pyle, “why hay?”  He could understand rocks, but hay?  Because if he outlasted his men while carrying a heavier load, he would feel strong.  But knowing he had carried a lighter load only made him feel weak.

This is human nature.  People take pride in their achievements.  They don’t take pride in any achievement attained by an unfair advantage.  Self-esteem matters.  And you can’t feel good about yourself if you need help to do what others can do without help. 

AN OLD CHINESE proverb goes, “Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”  Let’s say I am a fisherman in a small village.  I catch fish to feed my family and sell/trade for other family needs.  There’s a man in my village who asks me for a fish each day so he can eat.  I’m a caring person.  So I give him a fish each day.  So a pattern develops.  Each day he shows up when I come in from my fishing.  He takes the fish and goes away.  It works out well for him.  He doesn’t have to work.  He can live off of my kind charity.  Then I move.  Without me being there to give him a fish each day, he no longer can eat.  And dies.  If I only had taught that man to fish. 

Kindness can lead to dependency.  And once dependent, you become lazy.  Why develop marketable skills to provide for yourself when someone else will provide for you?  The problem is, of course, what happens when that charity ends?  If you’re unable to provide for yourself and there is no longer someone providing for you, what do you do?  Steal?

Dependency and a lack of self-esteem are a dangerous combination.  And they feed off of each other.  This combination can lead to depression.  Behavioral problems.  Resentment.  Bitterness.  Envy.  Or a defeatist attitude.

These are often unintended consequences of government programs.  A failed program, then, has far reaching consequences beyond the initial economic costs of a program.

LIQUIDITY CRISES CAUSE a lot of economic damage.  If capital is not available for businesses to borrow, businesses can’t grow.  Or create jobs.  And we need jobs.  People have to work.  To support themselves.  And to pay taxes to fund the government.  So everyone is in favor of businesses growing to create jobs.  We all would like to see money being easy and cheap to borrow if it creates jobs.

But there is a downside to easy money.  Inflation.  Too much borrowing can create inflation.  By increasing the money supply (via fractional reserve banking).  More money means higher prices.  Because each additional dollar is worth a little less. This can lead to overvalued assets as prices are ‘bid’ up with less valuable dollars.  And higher prices can inflate business profits.  Looks good on paper.  But too much of this creates a bubble.  Because those high asset values and business profits are not real.  They’re inflated.  Like a bubble.  And just as fragile.  When bubbles burst, asset values and business profits drop.  To real values.  People are no longer ‘bidding’ up prices.  They stop buying until they think prices have sunk to their lowest.  We call this deflation.  A little bit of inflation or deflation is normal.  Too much can be painful economically.  Like in the Panic of 1907.

Without going into details, there was a speculative bubble that burst in 1907.  This led to a liquidity crisis as banks failed.  Defaults on loans left banks owing more money than they had (i.e., they became illiquid).  They tried to borrow money and recall loans to restore their liquidity.  Borrowers grew concerned that their bank may fail.  So they withdrew their money.  This compounded the banks problems.  This caused deflation.  Money was unavailable.  Causing bank runs.  And bank failures.  Business failures.  And unemployment grew. So government passed the Federal Reserve Act of 1913 to prevent a crisis like this from ever happening again.  The government gave the Federal Reserve System (the Fed) great powers to tweak the monetary system.  The smartest people at the time had figured out what had gone wrong in 1907.  And they created a system that made it impossible for it to happen again.

The worst liquidity crisis of all time happened from 1929-1933.  It’s part of what we call the Great Depression.  The 1920s had a booming economy.  Real income was rising.  Until the Fed took action.  Concerned that people were borrowing money for speculative purposes (in paper investments instead of labor, plant and material), they put on the brakes.  Made it harder and more expensive to borrow money.  Then a whole series of things happened along the way that turned a recession into a depression.  When people needed money, they made it harder to get it, causing a deflationary spiral.  The Great Depression was the result of bad decisions made by too few men with too much power.  It made a crisis far worse than the one in 1907.  And the Roosevelt administration made good use of this new crisis.  FDR exploded the size of government to respond to the unprecedented crisis they found themselves in.  The New Deal changed America from a nation of limited government to a country where Big Government reigns supreme.

ONE PROGRAM OF the New Deal was Social Security.  Unemployment in the 1930s ran at or above 14%.  This is for one whole decade.  Never before nor since has this happened.  Older workers generally earn more than younger ones.  Their experience commands a higher pay rate.  Which allows them to buy more things.  Resulting in more bills.  Therefore, the Great Depression hit older workers especially hard.  A decade of unemployment would have eaten through any life savings of even the most prudent savers.  And what does this get you?  A great crisis.

The government took a very atypical moment of history and changed the life of every American.  The government forced people to save for retirement.  In a very poor savings plan.  That paid poorly by comparison to private pensions or annuities.  And gave the government control over vast amounts of money.  It was a pervasive program.  They say FDR quipped, “Let them try to undo this.” 

With government taking care of you in retirement, more people stopped providing for themselves.  When they retired, they scrimped by on their ‘fixed’ incomes.  And because Social Security became law before widespread use of birth control and abortion, the actuaries of the day were very optimistic.  They used the birth rate then throughout their projections.  But with birth control and abortion came a huge baby bust.  The bottom fell out of the birth rate.  A baby bust generation followed a baby boom generation.  Actually, all succeeding generations were of the bust kind.  The trend is growing where fewer and fewer people pay for more and more people collecting benefits.  And these people were living longer.  To stay solvent, the system has to raise taxes on those working and reduce benefits on those who are not.  Or raise the retirement age.  All these factors have made it more difficult on our aged population.  Making them working longer than they planned.  Or by making that fixed income grow smaller.

FDR used a crisis to create Social Security.  Now our elderly people are dependent on that system.  It may suck when they compare it to private pensions or annuities, but it may be all they have.  If so, they’ll quake in their shoes anytime anyone mentions reforming Social Security.  Because of this it has become the 3rd rail of politics.  A politician does not touch it lest he or she wishes to die politically.  But it’s not all bad.  For the politician.  Because government forced the elderly to rely on them for their retirement, it has made the Social Security recipient dependent on government.  In particular, the party of government who favors Big Government.  The Democrats.  And with a declining birth rate and growing aged population, this has turned into a large and loyal voting bloc indeed.  Out of fear.

A PROGRAM THAT straddled the New Deal and LBJ’s Great Society was Aid to Families with Dependent Children (AFDC).  Its original New Deal purpose was to help widows take care of their children.  When program outlays peaked in the 1970s, the majority of recipients were unmarried women and divorced women.  Because this was a program based on need, the more need you had the more you got.  Hence more children meant more money.  It also reduced the importance of marriage as the government could replace the support typically provided by a husband/father.  Noted economist Dr. Thomas Sowell blames AFDC as greatly contributing to the breakdown of the black family (which has the highest incidence of single-parent households).

With the women’s liberation movement, women have come to depend less on men.  Some affluent women conceive and raise children without a husband.  Or they adopt.  And the affluent no doubt can provide all the material needs their children will ever need.  Without a husband.  Or a father for their children.  But is that enough?

The existence of ‘big brother’ programs would appear to prove otherwise.  Troubled children are often the products of broken families.  Mothers search for big brothers to mentor these fatherless sons.  To be role models.  To show an interest in these children’s lives.  To care.  When no such role models are available, some of these troubled children turn to other sources of acceptance and guidance.  Like gangs.

AFDC has compounded this problem by providing the environment that fosters fatherless children.  And another government program compounds that problem.  Public housing.

POOR HOUSING CONDITIONS hurt families.  They especially hurt broken families.  Without a working husband, these families are destined to live in the cheapest housing available.  These are often in the worst of neighborhoods.  This is an unfair advantage to the children raised in those families.  For it wasn’t their fault they were born into those conditions.  So, to solve that problem, government would build good public housing for these poorest of the poor to move into.  Problem solved.

Well, not exactly.  Public housing concentrates these broken families together.  Usually in large apartment buildings.  This, then, concentrates large numbers of troubled children together.  So, instead of having these children dispersed in a community, public housing gathers them together.  Where bad behavior reinforces bad behavior.  It becomes the rule, not the exception.  Making a mother’s job that much more difficult.  And because these children live together, they also go to school together.  And this extends the bad behavior problem to the school.  Is it any wonder that public housing (i.e., the projects) have the worst living conditions?  And some of the highest gang activity? 

Government didn’t plan it this way.  It’s just the unintended consequences of their actions.  And those consequences are devastating.  To the poor in general.  To the black family in particular.  AFDC and public housing enabled irresponsible/bad behavior.  That behavior destroyed families.  As well as a generation or two.  But it wasn’t all bad.  For the politicians.  It made a very large constituency dependent on government.

THERE ARE SO many more examples.  But the story is almost always the same.  Dependency and a lack of self-esteem will beat down a person’s will.  Like an addict, it will make the dependent accept poorer and poorer living standards in exchange for their fix of dependency.  Eventually, the dependency will reach the point where they will not know how to provide for themselves.  The dependency will become permanent.  As will the lack of self-esteem.  Conscious or not of their actions, Big Government benefits from the wretched state they give these constituencies.  With no choice but continued dependence, they vote for the party that promises to give the most.  Which is typically the Democrat Party.

But how can you fault these politicians?  They acted with the best of intentions.  And they can fix these new problems.  They’ll gather the brightest minds.  They’ll study these problems.  And they will produce the best programs to solve these problems.  All it will take is more government spending.  And how can you refuse?  When people are hungry.  Or homeless.  Or have children that they can’t care for.  How can anyone not want to help the children?  How can anyone not have compassion?

Well, compassion is one thing.  When the innocent suffer.  But when government manufactures that suffering, it’s a different story.  Planned or not the result is the same whenever government tries to fix things.  The cost is high.  The solution is typically worse than the original problem.  And the poorest of the poor are pawns.  To be used by Big Government in the name of compassion. 

Of course, if Big Government were successful in fixing these problems, they would fix themselves right out of existence.  So as long as they want to run Big Government programs, they’ll need a stock of wretched, suffering masses that need their help.  And, of course, lots of crises.

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